Mumbai: The rising cost of capital may stall crucial infrastructure projects and hold back private equity (PE) funds worried about their valuations, exposing other industries to the risk of an investment slowdown as well, PE managers say.
Infrastructure companies such as power project developers accounted for more than 32% of all PE-funded deals in the country last year and 37% through the first half of this year. India needs investment worth tens of billions of dollars to reinforce its deficient public works, such as power plants, roads, ports and airports, to sustain economic growth.
Debt capital costs have increased for infrastructure companies in a regime of rising interest rates. Developers who fear they wouldn’t be able to service higher-cost debt may put borrowing plans on hold, delaying the execution of their projects, and in turn, lowering their equity valuations.
This could lead to a mismatch between the price a PE investor is willing to pay and the price at which a company’s promoter is willing to sell a stake. “The debt component, available at around 11% late last year, has now risen to 13-14%, especially for fresh infrastructure projects,” said Shahzaad Dalal, vice-chairman of Mumbai-based IL&FS Investment Managers, a fund that has $1.7 billion (Rs7,670 crore) under management.
Infrastructure businesses are typically capital intensive, usually funded by debt, which can be two to two-and-a-half times equity and as much as four times for larger projects.
Borrowing costs have risen this fiscal year, with the Reserve Bank of India (RBI) raising its overnight lending rate by 125 basis points and the cash reserve ratio, or the portion of deposits commercial banks must keep with RBI, by 150 basis points to cool credit growth and curb inflation.
One basis point is one-hundredth of a percentage point.
The Bombay Stock Exchange’s benchmark Sensex index has fallen about 30% from its high on 10 January on worries over rising inflation and interest rates, a slowing economy and its likely impact on corporate earnings. Also, foreign investors have pulled out a net $7.3 billion from Indian stocks this year.
Data from Venture Intelligence, a research service focused on private equity and venture capital, and which tracked the percentage data for PE investment in infrastructure, show that investors pumped $14.3 billion into India in 2007, and $6.7 billion in the first half of this year. This is a 26% increase over the $5.3 billion investment for the first half of last year.
“If equity valuations in infrastructure projects are impacted, that could lead to a mismatch in valuation expectations between promoters and private equity investors,” says a Mumbai-based investment banker. The banker declined to be named because his company advises on PE deals in the infrastructure sector.
“It is difficult to pinpoint companies that have had to go slow on their infrastructure projects, but companies that have not achieved financial closure before the rates shot up to current levels, may have to delay some of the projects or put them on hold,” says V. Jayasankar, executive director and head of the financial sponsors group at Mumbai-based Kotak Investment Banking.
Jayasankar added that the bigger infrastructure companies will continue to execute their projects as they will be able to leverage their strong balance sheets, while smaller firms may see delays.
An example of such a large company is Mumbai-based utility JSW Energy Ltd. Earlier this year, it failed to raise equity worth Rs2,918.6 crore from the market to fund the setting up of five new power projects.
Seshagiri Rao M.V.S., director (finance) at JSW Energy, said the company is using its own cash to avoid delays at these projects. Besides, it had tied up the debt component to finance the projects earlier.
“The (insufficient) availability of capital and the cost of capital have already slowed down infrastructure projects,” says Gaurav Mathur, managing director of Mumbai-based India Equity Partners, which manages a $350 million India-dedicated PE fund.
Vinayak Chatterjee, chairman of New Delhi-based Feedback Ventures, an infrastructure advisory firm, adds that there are two more factors delaying projects and lowering equity valuations: cost-push inflation because of high cement and steel prices and falling demand for some real estate projects and special economic zones.
Worse, a blow to infrastructure funding could affect PE investment in other sectors.
“The oft-repeated complaint from foreign investors in India is that the country lacks basic infrastructure. If there is less money going in to clear infrastructure bottlenecks, why would they pour money into India, even if it is to fund projects that have nothing to do with infrastructure-building?” the head of a PE firm said on condition of anonymity.